The Breakdown - The Fed Has Officially Pivoted

Episode Date: December 15, 2023

Everything from the FOMC and why the market reaction is jubilant. Today's Sponsor: Kraken Kraken: See what crypto can be - https://kraken.com/TheBreakdown Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Thursday, December 14th, and today we are talking FOMC Day, macro day. You know it. Before we get into that, however, if you're enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friends, well, yesterday was the FOMC meeting conclusion, and the Fed closed out the last meeting of the year by holding the policy rate steady between 5.25 and 5.5%. That's now four out of the last five meetings without a policy change, leading to the inevitable

conclusion that the hiking cycle is over. The Fed Chair Jerome Powell opened his press conference by stating, as we approach the end of the year, it's natural to look back on the progress that has been made towards our dual-mandate objectives. Inflation has eased from its highs, and this has come without a significant increase in unemployment. That's very good news. But inflation is still too high. Ongoing progress is not assured,

and the path forward is uncertain. However, while Powell struck a conservative tone in his overview, the message embedded in the economic projections provided by Fed officials was overtly optimistic. The meeting was accompanied by the quarterly releases of the summary of economic projections or SEP, where FOMC members, in their forecasts for a range of economic data. The message was clear. GDP growth was forecast

to stabilize to 2% by 2025. The unemployment rate was projected to remain low, peaking just above 4%. Inflation was expected to continue to decline, arriving at the 2% target by 2026, but rapidly closing the gap over the next year. Without exception, Fed officials are forecasting a soft landing. Now, the most important element of the SCP is the interest rate forecast, aka the dot plot. In September's SEP, the majority of Fed officials had penciled in one additional rate hike to close out this year, and major rate cuts pushed out into 2025. This quarter, the dot plot showed the average projection was that three rate cuts would be necessary in 2024, with five officials expecting even more than that.

Running through the current data, Powell noted labor market strength, moderating wage growth and cooling inflation. Core PCE, the Fed's preferred inflation metric, rose 3.1% over the past 12 months, a massive improvement from levels earlier in the year, but still obviously above the 2% inflation target. Powell said, the lower inflation readings over the past several months are welcome, but we will need to see further evidence to build confidence that inflation is moving down sustainably towards our goal. Still, Powell all but confirmed that the hiking cycle is over, stating, while we believe that our policy rate is likely at or near its peak for this tightening

cycle, our economy has surprised forecasters in many ways since the pandemic. We are prepared to tighten policy further, if appropriate. This statement, although carefully hedged, is the closest we could expect to a declaration that hikes are over. Powell is essentially saying that without a massive surprise in the data, there are no more hikes coming. He insisted that Fed officials do not want to take the possibility of further hikes off the table, but for the first time in years, the base case at the Fed is that rates will be coming down from here. Today's episode is brought to you by Cracken. For far too long, the whole financial system

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by Payward Ventures Inc. PVI, BVI, DBA, Cracken. Turning to press questions, Powell was immediately called upon to confirm the pivot. Asked whether a change in language meant the Fed was now biased towards softening policy with rate cuts, Powell said, participants didn't write down additional hikes that we believe are likely. Digging into the detail on what a cutting cycle would look like, Powell was asked whether he agreed with Governor Waller's recent analysis. Earlier this month, Waller had noted that as inflation comes down,

Fed rates above 5.25% would become increasingly restrictive and would need to be cut to maintain stable policy. Powell acknowledged it now that the Fed has likely arrived at the terminal rate, the next question is naturally, when it will become appropriate to begin dialing back the amount of policy restraint that's in place. However, he followed up by drilling home that, quote, We still have a ways to go, no one is declaring victory, that would be premature. We're moving carefully and making that assessment of whether we need to do more or not.

That's really the question that we're on. Powell asserted that the timing of rate cuts was not discussed in detail, but that there was a, quote, general expectation that this would be a topic for us moving ahead. Referring to the sublime forecast published by FOMC members, Powell was asked whether he was confident the economy had avoided a recession. Powell responded, I think you can say that there's little basis for thinking the economy is in a recession now. I think there's always the probability that there will be a recession in the next year,

and it's always a probability no matter what the economy is doing. He reinforced that the post-pandemic economy has been unpredictable and that, this result is not guaranteed. It's far too early to declare victory. Although Powell continuously reiterated that Fed officials didn't want to take the possibility of further rate hikes off the table, he noted the change in sentiment. It's not the base case anymore, he said, as it was 90 days ago. The recent rally in stocks and bonds was bought up, which indicates that markets are loosening policy

on behalf of the Fed. Powell was asked whether he was broadly comfortable with this. He responded, We have to do what we think is right. It's important that financial conditions are aligned with what we're trying to accomplish. I'm just focused on what's the right thing for us to do. This ambivalence stands towards a strong market rally is the polar opposite of Powell's stance earlier in the cycle, marking to many a major doveish turn. Now, most of the media questioning focused on interrogating exactly what the triggers for rate cuts would be. Powell was asked whether high growth into next year would mean a delay for cuts. He responded that high growth, quote, is not itself a problem. It's only a problem in so far as it makes it more difficult for us to achieve

our goals. Although if high growth brought with it higher inflation, Powell said that that would mean that rates would need to be held higher for longer. It was put to Powell that the Fed had been behind the curve in raising rates, and he was asked how the Fed would avoid waiting too long to cut. Powell responded, we're aware of the risk that we would hang on too long. We know that's a risk and we're very focused on not making that mistake. When asked whether the anticipated rate cuts for next year would necessarily be in response to economic weakness, Powell said, it could just be a sign that the economy is normalizing and doesn't need the tight policy. Powell had previously said that rates would need to be cut before inflation gets to 2% to avoid overshooting to the downside.

He was asked how early that would need to be but refused to pin down a specific number, instead noting that, quote, we'll be looking at a broad collection of factors. Finally, when asked whether he thinks achieving the last mile in the fight against inflation will be difficult, Powell said, we kind of assume it will get harder from here, but so far it hasn't. So obviously overall, this FOMC meeting marked a significant change in tone for the Fed. Powell didn't utter a single hawkish word throughout the press conference. He appeared broadly comfortable with the state of the economy and progress on the inflation fight. Although Powell stopped short of declaring victory and urged caution, his warnings lacked their usual emphasis.

The point was more that surprising economic data could make the Fed's assumptions incorrect, rather than trying to clearly signal the prospect of further rate hikes. That's why, ultimately, this meeting is being viewed as the much-fabled pivot. The Fed's base case is no longer that inflation will be stubborn and might require continued restrictive policy. The base case is now that inflation will glide back down to 2% over the course of the next year, and rate cuts will soon become appropriate. There was also no hint of panic. Powell was dismissive of the idea of economic deterioration, stating clearly that he doesn't see a recession on the horizon. Powell basically delivered a serene performance.

telling markets that the worst is likely over and to expect smooth sailing ahead. This theme was picked up strongly in media commentary. CNBC's Mike Santoli said, I think it was high hopes exceeded. I think we really did expect a nuanced type of pivot, but this was much more explicit. He didn't need to read between the lines. Powell didn't throw out as many of the typical disclaimers.

Bob Piscani agreed, calling the meeting about his Goldilocks as it gets. Derek Tang, an economist with monetary policy analytics, said, his pressors certainly had a tone of finality to it. He and the whole FOMC saw no need to push back with the dots against the market suspicion of earlier and deeper easing. Bloomberg economists, including Anna Wong, wrote, the FOMC showed a surprising willingness to endorse market pricing of rate cuts. The forecast in the latest SEP reflects a total embrace of the soft landing scenario. Now, one of the reasons that Powell was able to speak from such a confident position

was the further confirmation of moderating inflation. The CPI report was delivered on Tuesday showing headline inflation falling to 3.2% and core CPI holding steady at 4%. The more promising producer prices report was released on Wednesday morning, with both core and headline PPI showing no change on a month-over-month basis. Annualized core inflation came in at 2%. Across the board, PPI came in cooler than expected. Indeed, Powell noted that some Fed officials had actually modified their economic forecasts

after seeing these numbers yesterday morning. Now, the Fed's preferred inflation metric, the Personal Consumption Expenditures Index or PCE, has not yet been released for November. Nick Timrose of the Wall Street Journal crunched the numbers based on estimates, tweeting, based on the November CPI and PPI, headline PCE inflation likely declined last month. Core PCE inflation is projected to have been a very mild 0.06% in November. This could lower the 12-month core PCE index to 3.1%. The 6-month annualized rate would fall to 1.9% below the Fed's target.

Now, market action yesterday was a story of good news becoming better and better throughout the press conference. Stocks took multiple legs up each time Powell talked about rate cuts. Both the S&P 500 and NASDAQ indices closed the day with 1.4% gains, while the Dow Jones Industrial Average notched a new all-time high, also up 1.4%. That movement in the Dow was the most noteworthy reaction, representing a resurgence for the less flashy sectors of the economy. The leaders for the day weren't cutting-edge tech stocks, but rather rate-sensitive industries like financials, banks, and real estate.

Markets were pricing in a return to normality, where boring but profitable businesses can thrive without the threat of high interest rates continuing indefinitely. Bitcoin, of course, joined the rally, adding more than 4% throughout the day. Now, the relief was apparent across financial media. Josh Brown, the CEO of Ritt Holts Wealth Management, said, I'm crying, I have tears in my eyes. There's $6 trillion in money markets right now. We don't need it all to go into stocks.

If any meaningful portion of that $6 trillion goes into stocks, what else could you have asked for from 2023? You think about all the things that went bump in the night, all of the things we focused on day after day that could go wrong. None of them went wrong. They still could, but they haven't. That's the story of 2023. Liz Young, the head of investment strategy at SoFi, said,

I think you can throw caution to the wind for a little while. Things changed today. We moved to a different part of the conversation. We went from talking about hiking. Now they basically declared that that's over. I think you can, for the time being, jump into this rally, let it run. But as soon as that first cut comes into view, you get more nervous. Steve Leishman of CNBC put it more simply, stating, The Fed took a step towards the market rather than the other way around. Bloomberg's Lisa Abramitz captured the mood perfectly with her article entitled, Powell brings Tequila to Wall Street's rate cut party. She wrote, Powell had a chance today to push back against the market's recent euphoria around imminent interest rate

cuts. He did anything but he might as well have screamed, we did it and popped open some champagne. Joshua Green wrote, Economist on Bloomberg TV right now reacting to this data like Swifties with front row tickets. Now, Jeffrey Gunlock of Doubleline Capital gave his customary post-meeting summary. He went further than Powell dared to go out the podium, declaring the rate hiking cycle over. Gunlock said, Not only are they done, what a lot of people don't realize is that the Fed has been on hold for four of the last meeting, so it's a trend. Still, Gunlock's view of the economic prospects for the U.S. were a little bit

more pessimistic than Powell's. He said, they're going to cut by three quarters of a percentage point, or so says the Fed. I think that's pretty unlikely. I think that if they cut rates that much, they'll have to cut them by more than that. I think we're looking for recession next year. We're starting to see the good part of the pivot from the Fed, which is relaxation of financial conditions and that leads to for the moment, risk assets doing very well, and I suspect that's going to not be a trend change before the end of the year. After watching the markets move throughout the day, Gunlock noted that lower rates aren't always a good sign. Quote, there's something about if you break below 4% on the 10-year. I think it almost sounds like a

fire alarm going off relative to the economy. I think we might start to see the correlation of strong bonds and strong equities start to break down. Basically, Gunlock's view is that rate cuts will be a good thing until they aren't, signaling the transition from disinflation into a deflationary recession. Jim Bianco talked about this a little bit as well, tweeting. And now the markets have six rate cuts priced in for 2024, where the Fed says three. Six rate cuts make sense if you think 2024 will see a recession. There has never been a recession when the major averages have been making new all-time highs. The DGIA made a new all-time high today. A recession is supposed to be what the word implies. Job losses, business closures, no earnings,

etc. This is why the major averages do not boom in recessions or if recessions are coming. So six rate cuts and booming markets do not go together. And more than inflation falling to 2% is needed to get the Fed to cut six times, especially if the markets are booming. There is no reason to cut that much in a bull market. Still, while some tried to add this nuance, yesterday was not the day for macro doom. Powell brought out the punch bowl for the first time in a year, and markets are holding a celebration. And if there is anyone that can adequately capture the tone of loud, unrepented boomer bullishness, that is, of course, Mad Money's Jim Kramer. Somehow, Kramer took his bombastic style to another level on last night's show. He said, it's official people. When we buy stocks, we're no longer fighting the

Fed. Based on what we heard today, the Fed is now a little more worried about a slowdown than it is about inflation. This is the about face the bulls were waiting for. Lampooning Powell's reserve tone, Kramer added, he didn't say, we got a soft landing, nah, nah, nah, nah, that's what I would say. But we did indeed get the soft landing, so let's declare it with today's news. Interest rates have peaked, and now we have the wind in our backs. Powell doesn't want to declare victory, so I'll declare it for him. Rapping up his soliloquy, the newly self-crowned prince of Soft Landing Island said, the plane has landed, our seatbelts are unbuckled. So for now, macroheads enjoy it, we will see if it continues. But there are certainly worst times of year to be excited

about the market's prospects. Anyways, friends, that is going to do it for today's episode. One more big thank you to my sponsor for today's show, Cracken. Go to crackin.com and see what crypto can be. Until next time, be safe and take care of each other. Peace.